The financial planning profession is full of acronyms such as RMD, IRA, TSA and NUA. One acronym making a comeback due to the increase in the US Equity market is “NUA”. NUA stands for net unrealized appreciation and anyone with a 401k account containing stock might want to better understand it. NUA comes into play when a person retires or otherwise leaves an employer sponsored 401k plan. In many cases, 401k funds are rolled over to an IRA. However, if you hold company stock in the 401k plan, you might be best served by rolling the company stock out separately.
Before getting to an example, here are the gory details: The net unrealized appreciation in securities is the excess of the fair market value over the cost basis and may be excluded from the participant's income. Further, it is not subject to the 10% penalty tax even though the participant is under age 59-1/2, since, with limited exceptions; the 10% tax only applies to amounts included in income. The cost basis is added to income and subject to the 10% penalty, if the participant is under 59.5 and the securities are not rolled over to an IRA.
Suppose Mary age 62 works for a large company that offers a 401k plan. Over the years she has purchased $50,000 of XYZ company stock and it has appreciated over the years with a current value of $150,000. Therefore, Mary has a basis of $50,000 and net unrealized appreciation of $100,000.
If Mary rolls XYZ stock over to an IRA at retirement or termination, the full $150,000 will be taxed like the other funds at ordinary income tax rates when distributed. However, if Mary rolls XYZ stock out separately the tax rules are different and potentially more favorable. In the example above, if Mary rolls XYZ out she will pay ordinary income tax immediately on $50,000 but may obtain long term capital treatment on the $100,000 appreciation when the stock is sold; thus potentially saving several thousand dollars in income tax.
Here are some critical questions to review when considering taking advantage of this opportunity:
Have you determined whether you own eligible employer stock within your workplace retirement plan?
Have you determined whether you have a distribution triggering event that would allow you to take a lump sum distribution of your employer stock from your plan?
Have you discussed the special taxation rules that apply to lump sum distributions of employer stock and NUA?
Cost basis taxable as ordinary income
Net unrealized appreciation taxable at long term capital gains rates when stock is sold
Have you discussed the criteria necessary to qualify for NUA’s special tax treatment?
Qualifying lump sum distribution including stock of the sponsoring employer taken within one taxable year
Transfer of stock in kind to a brokerage account
Sale of stock outside of the current qualified plan
Have you discussed the pros and cons of rolling over your employer stock into an IRA, taking into consideration such things as available investment options, fees and expenses, services, taxes and penalties, creditor protection, required minimum distributions and the tax treatment of the employer stock?
Have you discussed the pros and cons of selling your employer stock within the plan, including the need for proper diversification?
Have you discussed with your tax advisor whether a NUA tax strategy would be beneficial from a tax planning perspective given your current situation?
These are a handful of the key questions that should be considered when deciding whether or not this opportunity makes sense for you. Professional guidance is always suggested before making any final decisions.
Matthew Trujillo, CFP®, is a Certified Financial Planner™ at Center for Financial Planning, Inc. Matt currently assists Center planners and clients, and is a contributor to Money Centered.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Matt Trujillo, CFP® and Tim Wyman, CFP® and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Strategies mentioned may not be appropriate for all investors.